By Kathy Fettke
One of the greatest benefits of real estate investing is the ability to leverage through creative financing. The use of OPM (Other People’s Money) can increase our returns infinitely. Let’s compare the ROI (Return on Investment) on three different investment vehicles: gold, stocks and real estate. Here are some sample case studies of three people with $100,000 to invest:
Sandra buys $100,000 worth of gold — using no leverage.
Joe purchases $100,000 in stocks, but he buys them on margin so his stock value is $200,000.
Pat uses $100,000 as a 20% down payment on $500,000 worth of income property.
Let’s look down the road 15 years to compare investment strategies, with the assumption that each investment increases 5% per year in value. (Please note that markets go up and down, so this example is only being presented for the sake of comparison.)
- In 15 years at a 5% return, Sandra’s gold would be worth $207,000.She has slept well at night knowing she owns “real money” and is thrilled that she’s doubled her money.
- In 15 years at a 5% return, Joe’s stocks would be worth $415,000. He has to pay back the margin so he nets $315,000 and he’s thrilled that he’s tripled his money.
- In 15 years at a 5% return, Pat’s properties are now worth $1 million. The initial 30 year fixed loan of $400,000 is now payed down to $200,000 so the profit is $700,000! Not bad for an initial $100,000 investment.
How could the difference in returns be so dramatic? It’s simple — the use of leverage can help us acquire much more than we could on our own. But there’s more! Pat had purchased income property so he was able to apply the monthly rental income toward the debt. In fact, the rents more than covered the expenses — so much so that Pat was able to receive a 10% annual return, which would net an additional $150,000 over the 15 year period. Add that net rental income to the $700,000 profit, and Pat’s total return is $850,000 in profit!
However, what if Pat put all his rental income toward paying off the loan instead of pocketing it? He’d have all properties paid off in 15 years thanks to the accelerated pay-off. Pat would be a millionaire! Plus, those properties would be netting an annual rental income of approximately $100,000 per year. Remember, that’s the same amount of money Pat started with.
Let’s summarize these numbers:
$100,000 at 5% over 15 years became:
$207,000 for gold
$415,000 in stocks
$1 Million plus $100,000 annual rental
income for life.
Actually, no. There’s more: Taxes. Both Sandra and Joe will need to pay capital gains taxes if they decide to cash out. Today, long-term capital gains tax is normally 15%, however Congress is considering eliminating the capital gains tax. There is discussion of including it as ordinary income, which could bring it up to as much as 50% in tax.
If Pat wanted to cash out, the capital gains tax would also apply, unless he decided to use the funds to buy another property through a 1031 exchange. Additionally, Pat would have enjoyed many deductions from owning real estate that would not be available with stock or gold investments.
Real estate isn’t always easy because it does require hands-on management. However, that manager doesn’t have to be you. There are very good companies who specialize in property management. Real estate also requires that you buy right. There are many agents who specialize in finding high-yielding rental property. Be careful about working with agents who don’t own rental property because they may not understand it.
If you are new to real estate investing, consider working with someone who is highly experienced AND successful in what you are trying to achieve.
You can download a free report, “7 Steps for New Real Estate Investors” at: www.RealWealthNetwork.com/411 And, while you’re there, join the network for free on-going real estate education, resources, market updates and referrals to leading agents, property managers and wholesalers nationwide.
Kathy Fettke is the founder and CEO of Real Wealth Network “The Real Estate Investors Resource.” Members have access to free education, resources and referrals to turn-key rental properties around the United States. Real Wealth Network has over 8,000 members, so the shear power of numbers allows the group to acquire properties at huge discounts. Membership is free. Kathy is also host of The Real Wealth Show on KABC Los Angeles and on iTunes and is a regular guest expert on ABC, CNBC, CBS Market Watch and NPR.